Economist, Telegraph Columnist, Broadcaster

BNE INVISIBLE HAND: Rhetorical Wizard Draghi Conjures Up QE Pledge

Mario Draghi is being hailed, once again, as a rhetorical wizard. The president of the European Central Bank has done it again. After the October meeting of the ECB’s Governing Council, Draghi dropped hints the Frankfurt-based bank would soon be unleashing yet more quantitative easing across the Eurozone, further lowering interest rates, or both.

No matter that the ECB has been churning out €60bn of virtually printed money a month since March and is committed to do so until September 2016. That’s a Euro-QE programme of €1,100bn – an astonishing 8% of the Eurozone’s annual GDP. No matter, also, that the ECB’s benchmark interest rate is 0.05%, with the central bank deposit rate at minus 0.2% – both record lows – or that Draghi has previously said such rates were at “their lower bound”. The ECB is now “vigilant” – a trigger word previously pointing to imminent policy action.

On cue, stocks and bonds rocketed in expectation that, at its next meeting in December, the ECB will unleash an additional stimulus. The Europe-wide Stoxx 600 share index closed 2% up, with Italian and Spanish benchmark 10-year yields dropping to their lowest levels since April.

Across much of “New Europe”, too, share prices rose. With the European Bank for Reconstruction and Development predicting little overall regional growth this year, and a lacklustre 1.4% expansion in 2016, Western Europe’s performance is vital. It’s difficult to envisage a meaningful upswing in Central, Eastern and Southeast Europe, in fact, unless the Eurozone is buoyant. “The outlook for our region is improving on the back of Eurozone monetary easing – there is definitely scope for optimism,” the EBRD said, when releasing its last round of economic forecasts in May. “But the on-going Russian recession is cause for concern”.

When Eurozone QE began earlier this year, EBRD economists moved quickly to upgrade their growth forecasts for Poland, Slovenia, Hungary and the Slovak Republic, a move the institution said, “mainly reflected the Eurozone monetary stimulus”. We could soon see a similar uprating of regional growth projections – by the EBRD, other multi-laterals and a range of commercial institutions – if Draghi delivers on his pledge.

The ECB supremo has now taken on the air of a rhetorical magician. Back in mid-2012, when the single currency was imploding, the smooth-talking Italian pledged to do “whatever it takes” to save the euro. Previously febrile bond markets calmed in response, and Eurozone officials and politicians claimed the crisis was “solved”. So effective has Draghi been, his supporters point out, that he hasn’t even needed to implement the so-called Outright Market Transactions programme, a more sustained form of central bank sovereign bond-buying. Just the prospect that he might has held bond markets in check across the Eurozone’s fragile “periphery”.

Amidst the QE sugar-rush, though, think twice before swallowing Draghi’s money-printing kool aid. “Deflation” is often cited as the main motivation for QE – in the US, UK and Eurozone – but this is actually nonsense. Yes, Eurozone inflation was negative in September, at minus 0.1%, down from 0.1% the month before – and that’s below the 2% target. But take out the 50% oil price drop over the last and much lower food prices too, both of which will soon fall out of the numbers, and Eurozone inflation was easily positive last month, at around 1%.

The real reasons for QE are rather different. Western politicians are certainly determined to keep the asset price rally going, pushing further into the future the inevitable market turmoil when the money-printing (and the prospect of future money-printing) finally ends. Central bankers seem happy to oblige, even though such blatant bubble-blowing, history suggests, is unlikely to end well.

In addition, the big QE banks in London, Washington and Frankfurt, along with Tokyo and Beijing, are engaged in an ongoing currency war – all of them trying to secure a more competitive exchange rate to boost their exports. Western nations have the further incentive of QE-ing their way to weaker currencies to reduce the burden of the “hard currency” debts they owe to the rest of the world.

Draghi’s next move probably now depends on America’s mighty Federal Reserve. If America’s central bank does finally raise rates for the first time since 2006 in early December, as expected, the euro would fall against the dollar. That, in theory, makes additional euro-QE less likely.

I suspect the Fed won’t put up rates, though. In fact, we could yet see another large dollop of US money-printing – QE4 – which would pressure on Draghi to respond, turning his vigilance into action.

It may be that Draghi and his political masters are so determined to depreciate the euro that the ECB prints more even if the Fed does puts up rates, reinforcing the rising-dollar-falling-euro trend.

Whatever happens, exchange rate movements across New Europe will have little to do with actual trade flows over the coming months, amidst an ongoing QE battle between the world’s most powerful central banks.